SteadyOptions is an options trading forum where you can find solutions from top options traders. TRY IT FREE!

We’ve all been there… researching options strategies and unable to find the answers we’re looking for. SteadyOptions has your solution.

The Astonishing Story Behind XIV Debacle


During the market's closing hour on Monday, February 5th, some sort of "flash crash," likely triggered by margin calls, attacked the CBOE Volatility Index (INDEXCBOE:VIX), also known as the "fear index." What was a bad day, turned into a never before seen move. Here is it: 

VIX2718.png

 

Whatever it was, the VIX went from 17% to 37% in a matter of two-hours, or up 115%. That is the largest percentage gain in the VIX in one day ever recorded. 


Even then, while that is a huge move, it wasn't really market disruptive in any great way other than, the market had a bad day. But then the after hours margin calls came in -- and that was an unmitigated disaster for one particular instrument of interest to us: Credit Suisse AG - VelocityShares Daily Inverse VIX Short Term ETN (NASDAQ:XIV). 

DON'T LISTEN TO TV 
The reporters on television have no understanding what XIV is -- it is not a naked short bet on VIX. No, it is an investment in the core underlying principle of market structures, driven by positive interest rates, known as Contango. 

Remember, the XIV is the opposite of VXX, and the expected value of VXX is zero. Here it is, from the actual VXX prospectus: 
 

vxxzero.jpg


This instrument is not a radical short trade, it is fundamentally an investment in an ETN that reverses the value of an investment that is ultimately expected to be zero, which made it so good, for so long, and would have for several more decades. 

WHEN A LINE BECOMES THE FOCUS 
A little detail in the prospectus of XIV is that, hypothetically, should it lose 80% of its value from the close, it would cause a "acceleration event." That means that if the XIV sunk to 20% of its value, it would go to zero and the ETN would go away (and start over later). 

Now, obviously, this had never happened to XIV before, but it's only a decade old. When scientists back-tested XIV all the way back to the 1987 crash and including the 9/11 terror attacks, they noted that even then, XIV would not have suffered a 80% decline in a day. But we have never seen such a market with so many naked short vol sellers as we have today. 

As a barometer, even as crazed as Monday was, here is how XIV closed: 

XIVclose2718.png


Down 14.32% is ugly, but, it's just a day -- a bad one, but nothing really all that crazed. Then the after hours session happened, and the best anyone can tell, as of this writing, is that some firm (or fund) had to unwind a short volatility position due to a margin call. 

That meant they had to buy the front month expiration of the VIX futures, leaving the second month unchanged. That little detail is everything, because the XIV is an investment on contango -- when the second month is priced higher than the first month. This is a market structure apparatus -- we could call it "normal market structure." 

But, with a flood of buying to cover short front month futures, the XIV started tumbling after hours. At first, social media saw it as a buying opportunity. Then it started dropping faster. Then disaster struck. 

The XIV dropped more then 80%: 

XIVah2718.png


The financial press did its best to cover it, but after a 2 minute segment on CNBC, there was nothing left to say because of one major rule inside the XIV prospectus. Here it is: 
 

xivacc.png


In that fine print, it reads that if the value of XIV dips to 20% of the closing value (if it is down 80%), the fund stops. That is, since this trade, if done with actual futures contracts, can actually go negative, the ETN stops itself out at a 80% one day loss. This is why we investors use the ETN, knowing that a 100% loss is the worst that can happen, as opposed to the futures, where much worse than 100% loss can occur. 

And the greatest burn of it all 
As of Tuesday morning the VIX is down huge (of course it is), the market structure has held (of course it did), and XIV would be having a very good day (of course it would). 

But, worse --- it turns out, as far as we know (still speculation), while it's hard to swallow, that the unwinding was done by none other than Credit Suisse itself. Yes, the creators of the ETN had another concern, beyond the assets under management -- and here it is -- -- look at the largest shareholder
 

xivholders.jpg

Credit Suisse quietly became the single largest holder of the very instrument it created, and by a huge amount. So, as 4pm EST came around, a bad day in XIV, but survivable, became the death knell, because the largest holder, the XIV's custodian, panicked, and covered. 

But, Credit Suisse could not very well just sell millions of shares of XIV in a thinly traded after hours session, so it turned to the VIX futures market. 

It appears, as of this writing, that this has actually occurred. While Credit Suisse (the issuer of the ETN) has yet to comment, it appears that whatever this "flash crash" did, whatever margin calls were triggered after hours, the short vol trader was in fact the firm -- it unwound positions in a size that the market has never seen before, and that means that it looks like XIV is possibly going to some very, very low number -- like $0, low. 

It's with great regret that as of right now, we do believe XIV is, for all intents and purposes, gone, from a little rule hidden deep in the prospectus that no one gave much concern and that got blasted away when the top holder in the note was the custodian itself. 

It's a reminder that the real danger to a portfolio is not a bear market -- we recover from those quite nicely as a nation -- it's the delirium that happens when a bull market gets totally out of control and margin is used excessively in a spurt of just a few days. And by margin, we don't mean normal, everyday investors, we mean the institutions -- even the ones we entrust to be custodians of our investments. 

So that's it. XIV likely would have done just fine after this moment in time in the market, will not be given that opportunity to recover. It has been blown out on the heels of yet another Wall Street debacle, which no one seems to even understand, yet. 

The author is long shares of XIV in a family trust. 

Ophir Gottlieb is the CEO & Co-founder of Capital Market Laboratories. He contributes to Yahoo! Finance, CNNMoney, MarketWatch, Business Insider, and Reuters. This article was originally published here.

What Is SteadyOptions?

Full Trading Plan

Complete Portfolio Approach

Diversified Options Strategies

Exclusive Community Forum

Steady And Consistent Gains

High Quality Education

Risk Management, Portfolio Size

Performance based on real fills

Try It Free

Non-directional Options Strategies

10-15 trade Ideas Per Month

Targets 5-7% Monthly Net Return

Visit our Education Center

Recent Articles

Articles

  • Are Covered Calls a ‘Sure Thing?’

    Most covered call writers enjoy the regularity and reliability of the position. In the majority of cases, the covered call will be profitable, even when underlying shares are called away. This assumes that the strike is higher than the basis in the underlying, and that the call writer understands the real limitations to the strategy.

    By Michael C. Thomsett,

    • 0 comments
    • 409 views
  • Lessons from Bill Ackman's comeback

    Bill Ackman is an American investor, hedge fund manager and philanthropist. He is the founder and CEO of Pershing Square Capital Management, a hedge fund management company. Ackman is considered by some to be a contrarian investor but considers himself an activist investor.

    By Kim,

    • 1 comment
    • 1,584 views
  • Steady Futures 2019 Performance Analysis

    Steady Futures began trading the 50K portfolio in July 2019. It produced a 8.5% return during its 6 months of performance (18.0% annualized). We had three goals when we developed this system. First, we wanted a robust system that benefits from turmoil in the markets.

    By RapperT,

    • 0 comments
    • 286 views
  • SteadyOptions 2019 - Year In Review

    2019 marks our 8th year as a public service. It was a good year overall. We closed 151 winners out of 232 trades. Our model portfolio produced 41.7% compounded gain on the whole account based on 10% allocation per trade. We had only two losing months in 2019. 

    By Kim,

    • 0 comments
    • 413 views
  • Momentum 2019 Performance Analysis

    Steady Momentum had an excellent first year of publication, producing significant gains in both of the published strategies. The most popular strategy writes (sells) out of the money puts on equity indexes and ETF’s, and returned 19.1% for the year, beating our benchmark by approximately 5.5%.

    By Jesse,

    • 1 comment
    • 507 views
  • SteadyOptions 2019 Performance Analysis

    Steady Options model portfolio produced 41.7% gain in 2019. This is a very good return by any standards, but well below our long term returns. In the name of full transparency and our continuous learning, we are providing a full analysis of the 2019 numbers.

    By Kim,

    • 0 comments
    • 1,373 views
  • Anchor 2019 Performance Analysis

    Steady Options now has a full year of trading the Leveraged Anchor Account under its belt. (Technically since today is December 30, the values used herein are one day off.) To say things went as designed is an understatement - the strategy outperformed the S&P 500 in 2019 by 7.2% while being hedged.

    By cwelsh,

    • 1 comment
    • 685 views
  • A Reliable Method for Picking the Underlying

    A lot of emphasis is placed on selection of one strategy over another. Are you conservative or a speculator? Are you trying to make fast money or hedging equity positions? In fact, this is a primary concern among traders. The strategy should match the risk profile, of course. But there is much more to how and why you trade options.

    By Michael C. Thomsett,

    • 0 comments
    • 466 views
  • Total Stock Market Index Funds: A Diversification Illusion?

    I’m a fan of index funds and diversification. Low costs, low turnover, and passively managed exposure to thousands of stocks make Total Stock Market (TSM) index funds great starting points for stock market exposure. In fact, most investor portfolios I see are insufficiently diversified to a point where a TSM index fund would be a material improvement.

    By Jesse,

    • 0 comments
    • 638 views
  • Back to the Basics: How to Get Started Trading Options

    To those of us involved in the Steady Options community, options trading is almost second nature. But most investors, and even most traders, don’t trade options. There may be a variety of reasons why this is the case, but I believe it’s mostly related to the learning curve of understanding a completely new concept.

    By Jesse,

    • 0 comments
    • 418 views

  Report Article

We want to hear from you!


Over the long term, shorting volatility is still a winning strategy. The key is position sizing. Check out our performance - VXX and SVXY trades are still very positive, despite the last two losers. But we are doing reduced position sizing (5% instead of 10%) due to higher risk.

Share this comment


Link to comment
Share on other sites

But what’s troubling about Ophir’s article is that it’s not the market that determined the fate of XIV/SVXY but a single rogue player with huge monetary influence.  There’s no way to rationally play the odds in such an environment- is there? 

Share this comment


Link to comment
Share on other sites
4 hours ago, NikTam said:

But what’s troubling about Ophir’s article is that it’s not the market that determined the fate of XIV/SVXY but a single rogue player with huge monetary influence.  There’s no way to rationally play the odds in such an environment- is there? 

I think our SVXY collar proves that you can still make money if you know what you are doing.

Share this comment


Link to comment
Share on other sites


Your content will need to be approved by a moderator

Guest
You are commenting as a guest. If you have an account, please sign in.
Add a comment...

×   Pasted as rich text.   Paste as plain text instead

  Only 75 emoji are allowed.

×   Your link has been automatically embedded.   Display as a link instead

×   Your previous content has been restored.   Clear editor

×   You cannot paste images directly. Upload or insert images from URL.

Loading...

Options Trading Blogs Expertido